Many smaller investors are failing to take advantage of a tax-saving strategy called a 1031 exchange. While a common strategy for many commercial investors, small real estate investors can also reap the rewards offered by this opportunity.

A 1031 exchange, or a tax-deferred exchange, allows investment property owners to defer taxes on sold property by reinvesting proceeds into a "like-kind" investment property or properties. Under current tax laws, in order to completely defer the payment of tax with your 1031 exchange, among other things, the replacement property must be of equal or greater value, and all the equity from the sold investment property must be reinvested in the new investment property or properties.

This provision of the IRS code – section 1031 – is an excellent strategy for taking capital appreciation while deferring cash outlays for taxes. Investors can also take advantage of the broad definition of a “like-kind” investment to expand a portfolio – for instance, a rental house can be exchanged for unimproved land.

A 1031 Exchange can also be an estate planning strategy; because the tax liability is forgiven upon the death of the investor, heirs benefit from a stepped-up basis in the property.

There are restrictions, however. Investors must identify a new investment property within 45 days of a sale and close the sale of the replacement property within 180 days to avoid paying taxes. There are no extensions if you fail to meet the deadlines.

If you need to sell the replacement property within the time limitations specified by the code, you may have to pay taxes sooner than expected.
Most important, investors cannot have access to or control over the sale proceeds, which are held in escrow by the qualified intermediary.
Whether a 1031 exchange makes sense for you can depend on a number of factors; contact Ablon and Company to discuss your particular situation.

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